This, I think, is the problem -- the insurers of the CDS instruments (for example AIG) were levered at, oh, say, 50-1.
Which means that with a 3% fall in price of the things they were 'insuring' -- they get wiped out.
Which means the people who were counting on them to insure them--have to eat the losses.
Which they weren't counting on.
Which means they have to liquidate *other* assets to make up the shortfall.
Which drives down the price of the other assets.
Which affects the capitalization ratios of other players.
Which means the new players are subject to margin calls.
Which means *they* have to liquidate.
Apply, lather, crash.
Cheers!
The economy doesn’t care. Just because it impacts you doesn’t always mean that something impacts everyone else.
Whether I owe you money and can pay, or can’t pay, makes zero difference to the broader economy.
You just think that it *should*, but the total banking system will see the same level of deposits whether you have the money or me...be it nothing...no deposits...or something...some deposits.
I can owe you money. You can owe me money. Doesn’t matter to the broader economy. Same level of deposits in the bank either way, just from the accounts of different people.